Molycorp was an unusually large, complex and contentious chapter 11 case, but in a number of respects it was no different than many business reorganization cases which get filed every day. The key one is that it had virtually no unencumbered assets with which to pay the debtor’s professionals and the professionals retained by the official committee of unsecured creditors. This has become a common situation, particularly in large cases with complicated capital structures which often feature more than one tranche of secured debt. The only payment source for professionals in these cases is a “carve-out” from proceeds of collateral agreed to by the secured lenders.

Counsel for official committees in chapter 11 cases of this nature take on a challenging role. Official creditors’ committees are tasked with numerous important duties and granted significant powers under the Bankruptcy Code. In most instances, professionals for the debtor and the secured lenders have been planning the course and timing of the bankruptcy filing and negotiating important pleadings and documents (and the carve-out for the debtor’s professionals) for weeks or even months. The official committee, however, is not formed and counsel is not engaged until after the case has commenced. At that point, a tremendous amount of information must be digested and analyzed and there are numerous important motions to address, almost always on an expedited basis. Counsel must also negotiate the carve-out during this period or else risk non-payment.

Secured lenders consent to carve-outs because they generally prefer chapter 11 cases, where the going concern value of collateral can be preserved and realized through a reorganization or a sale of the debtor’s business, instead of fast liquidations under chapter 7 of the Bankruptcy Code or exercising foreclosure remedies under state law. Official creditors’ committees are a key component of chapter 11 cases. Even though secured lenders know that committees usually will seek to extract some value from a secured lender for the benefit of unsecured creditors, such as by challenging liens or contesting enterprise valuations, they know also that if there are no unencumbered assets, most bankruptcy judges will require lenders to “pay the freight,” i.e., cover the costs of the chapter 11 cases.

In almost all chapter 11 cases, therefore, secured lenders (grudgingly) agree to a carve-out that will ensure that professionals for a creditors’ committee get paid for at least some of their work. The agreement usually comes only after hard negotiations (typically after sabers have not only been rattled but also drawn), as part of an order that provides new financing and/or permits a debtor to use cash proceeds of collateral in order to operate during the pendency of the bankruptcy case.

The question before Judge Sontchi in Molycorp was whether the carve-out served as a hard cap on fees. Molycorp, following months of hostility between the official creditors’ committee and its secured lender, succeeded in confirming a plan of reorganization. The secured lender early in the case had consented to a carve-out of no more than $250,000. In the end, the committee sought payment of nearly $8 million in fees and expenses for its counsel. The secured lender objected, arguing that the only source of funds were from its collateral, and that because the proceeds of its collateral could not be used without its consent, the fees of the committee’s professionals were capped.

The committee relied on Section 1129(a)(9) of the Bankruptcy Code. Among the requirements which must be met when a plan of reorganization is confirmed is that all administrative claims (i.e., claims incurred during the bankruptcy case that were necessary for the administration of the debtor’s bankruptcy estate) must be paid in full. Fees of a creditors’ committee’s professionals are administrative claims. The committee argued that once Molycorp’s plan was confirmed, Section 1129(a)(9) controlled and that the carve-out in the financing order was no longer operative.

The secured lender responded by noting that Section 1129(a)(9) provides that the holder of an administrative claim may agree to accept less than full payment. In its view, the carve-out had effectively served as such an agreement.

Judge Sontchi sided with the creditors’ committee. He determined that the carve-out in the financing order could not limit the payment of committee counsel’s fees as administrative expenses under a confirmed plan of reorganization. The payment of administrative expenses under Section 1129(a)(9), he stated, is “a fundamental statutory requirement of the Bankruptcy Code[.]”

In Judge Sontchi’s view, the carve-out agreed to in Molycorp, which he referred to as “standard”, was only intended to be applicable if Molycorp’s reorganization had failed. If the case had been converted to chapter 7 or dismissed, and the collateral liquidated, the $250,000 would have been the maximum that the committee’s professionals could have received. But he ruled that the carve-out could not limit payment of committee counsel’s fees pursuant to Section 1129(a)(9). He acknowledged the secured lender’s argument that a carve-out provision might serve as an agreement to accept less than full payment under a later plan. However, he determined that the language in the carve-out provision before him “does not contain any language that can compel an automatic disallowance of [committee counsel’s] fees.” He also signaled, in a footnote that appears to be intended for secured lenders in future cases, that he might not be willing to approve a carve-out provision that were to contain such language.

The first few weeks of representing a creditors’ committee in a large, complex and fast-moving case have been likened by some practitioners as comparable to trying to slow down a freight train by stepping in front it. Judge Sontchi’s analysis, if followed by other courts, will provide committee counsel during these fraught periods with at least a bit more leverage in negotiations with secured lenders over carve-out provisions and payment of fees.

Ben Feder is special counsel in Kelley Drye & Warren's New York office. He focuses his practice on bankruptcy and restructuring matters. Mr. Feder represents bank lenders, debtors, bondholders, creditors' More

Stay Connected

About the Bankruptcy and Restructuring Group

The firm represents creditors’ committees, debtors, financial institutions, indenture trustees, bondholders, landlords, suppliers and trading partners in out-of-court restructurings, bankruptcy reorganizations, and liquidations and related litigation. Our lawyers are at the forefront in working with clients to develop and execute strategies to maximize recovery, minimize exposure and realize the best business outcome.